Arizonans' Options When Facing Foreclosure

September 19, 2010

The current economic crisis has affected individuals and families across the county. The residents of Arizona are no different than the rest of America, as many of us, our friends, or our neighbors face foreclosure on our homes.

Foreclosure Statistics for July 2010

According to numbers released by Arizona State University (ASU) Realty Studies, 43 percent of existing homes sold in the Phoenix area in July were foreclosures. This number is up from 36 percent and 33 percent respectively in the prior two months.

While the number of foreclosures sold in the existing housing market is still increasing, foreclosures for July 2010 were down from the number of foreclosures in July 2009. An ASU real estate professor reports that the number of single-family homes foreclosed upon in July 2010 was 3,900, down from last July's 4,200.

Anti-Deficiency

With the number of single-family homes sold through foreclosure on the rise, debtors who were foreclosed upon have many questions. Chief among these are: What if the sale of the house doesn't yield enough money to cover the outstanding mortgage debt? What happens to the second mortgage?

In Arizona, there are two anti-deficiency statutes that protect homeowners. Arizona Revised Statutes (ARS) Section 33-729(A) and ARS Section 33-814(G) protect borrowers by stating that if a foreclosed home is sold and does not receive enough money by way of sale to cover the amount of the outstanding mortgage, the lender is NOT allowed to seek recovery against the debtor for the difference between the sale price and the amount of the outstanding mortgage.

The anti-deficiency statutes only apply to purchase money mortgages and deeds of trust, however. A purchase money mortgage, as defined by ARS Section 33-7299(A), is "a mortgage given to secure the payment of the balance of the purchase price, or to secure a loan to pay all or part of the purchase price ..." The definition does not extend the anti-deficiency protections to borrowers who have assumed the mortgage, home equity loans and most second mortgages. Similar protections are extended to deeds of trust sold at trustee sales by ARS Section 33-814(G).

One important difference to note is that ARS Section 33-7299(A) applies to only the judgment debtor, but ARS Section 33-814(G) can apply to either the debtor OR the guarantor of the mortgage.

Property Limitations on Anti-Deficiency

There are also limitations on what property qualifies for anti-deficiency protection. Limitations on property include:
- Property must total two and one-half acres or less;
- Property must be a completed, single, one or two family dwelling; and
- Property must occasionally occupied by the owner or another party

Both ARS Section 33-7299(A) and ARS Section 33-814(G) explicitly state the first two restrictions. The third restriction comes from the Arizona Supreme Court, who addressed the issue of occupancy in the case of Mid Kansas Federal Savings & Loan Association v. Dynamic Development Corp.

IRS Form 1099-C

Even if a property and a mortgage fall under the anti-deficiency statutes and the debtor is not liable for the deficiency, the debtor may have an additional concern. In general, the Internal Revenue Service (IRS) considers debt that is forgiven to be taxable income. This means that the debtor may be taxed on the difference between the amount of the mortgage paid back to the lender and the total amount of the mortgage.

When the debt is forgiven, the lender typically issues the debtor an IRS form 1099-C to report the monies that the debtor no longer has an obligation to repay. However, there are certain situations where cancellation of debt income is not considered taxable by the IRS, including:
- Bankruptcy -- the IRS does not consider debts discharged through bankruptcy to be taxable income
- Non-recourse loans -- this is a loan where the lenders' only remedy when the borrower defaults is repossession
- Insolvency -- when the value of the debtor's total liabilities exceed the value of the debtor's total assets

Mortgage Forgiveness Debt Relief Act of 2007

The Mortgage Forgiveness Debt Relief Act of 2007 generally considers forgiven debt on a principal residence to be non-taxable. However, only debts up to $2 million, discharged in calendar years 2007 through 2012 fall under the Act's provisions. The Act will exclude debt forgiveness from income when:
- The property was the principal residence
- The debt was for the purchase, construction or substantial improvement of the property
- The property was the debtor's principal residence for at least two of the past five years

Bankruptcy

Bankruptcy may provide a debtor options for dealing with mortgage debt. As stated above, debt discharged through bankruptcy is not considered taxable income by the IRS. Plus, if your home is in foreclosure, filing for bankruptcy will halt the foreclosure process.

If a debtor wants to keep the house, Chapter 13 may be an option. Chapter 13, also known as "wage earners' bankruptcy," allows the debtor to reorganize debts into a monthly payment to be paid over three to five years. If a debtor is behind on making mortgage payments, Chapter 13 allows the debtor to catch-up on the missed payments over the course of the repayment period.

Also, if there is a second mortgage on the home, Chapter 13 allows for the court to strip the second mortgage. This can occur when the there is not enough equity in the home after deducting the senior liens (often the first mortgage).

Filing for Chapter 7 bankruptcy, often referred to as "liquidation," is another option that a debtor may have. Chapter 7 allows the debtor to have the debt discharged without having to worry about deficiency or reporting the forgiven debt as income to the IRS. If the debt is discharged, though, the debtor will not be able to keep the home.

Bankruptcy and foreclosure are complex issues. In order to really understand the issues that affect your particular situation, you should speak with an attorney to discuss the specifics of bankruptcy, anti-deficiency and the Mortgage Forgiveness Debt Relief Act of 2007.

Article provided by Charles M. Sabo, P.C.
Visit us at www.charlessabo.com